Next crisis won’t come from the emerging markets

Opinion: The real Fragile Five are all developed economies

By

MatthewLynn

AFP/Getty Images

France’s best days are far in the past.

No big financial story is complete these days without a handy acronym or alliteration to encapsulate it. From the rise of the BRICS, to the PIGS of peripheral Europe, to the MINTs that are meant to represent the next wave of stars (Mexico, Indonesia, Nigeria and Turkey, in case you were wondering), they are a quick shortcut to understanding a complex subject.

Right on cue, the plunge in emerging markets that started this year has given us, courtesy of the analysts at Morgan Stanley, the Fragile Five. Comprised of Indonesia, South Africa, Brazil, Turkey and India, they have been singled out because their big current-account deficits mean they are acutely vulnerable to a sudden exit of foreign capital.

Advisers Maintain Faith In Emerging Markets

If there is another big storm about to blow through the global economy, that is where it will come from, we are told.

The trouble is, it isn’t true. The real Fragile Five are not the five emerging markets mentioned by Morgan Stanley, but are, in fact, five developed economies that hardly anyone is worried about.

True, some of the emerging economies have sucked in a lot of capital, and run big trade deficits as a result. But there is nothing really wrong with that. So do many developing economies.

The next crisis will start, as did the last one, in one of the developed economies. It is far more likely to come from France, Germany, Britain, Australia or Canada. Those nations are the real Fragile Five — and far too few investors are worrying about them.

In fairness, there is some logic to the five emerging markets that have been singled out as likely to run into trouble as the global capital markets wobble. Any economy that depends on foreign capital to fund itself is vulnerable to sudden swings of mood. If that money suddenly heads home, it can be plunged into crisis very quickly. Currencies tumble, and interest rates have to rise very quickly — as Turkey has just discovered.

And yet, there is nothing intrinsically bad about developing nations drawing in foreign capital. If it is being invested in new roads, airports and factories, it is usefully deployed. Fast-growing nations find it hard to finance themselves completely internally, in the same way that fast-growing companies do.

In fact, the real risks are in the developed world. With unaffordable debts, slow growth, unbalanced economies, bloated banking systems, and often big trade deficits as well, that is where the trouble will come from. Here, instead, are the real Fragile Five that investors should be worrying about.

One: France. The only economic measure on which France outperforms these days is the rate at which it is racking up fresh debt. This year, the government admits debt will go past 95% of gross domestic product, close to the 100% level at which it starts to get out of control. The country is on the edge of a fresh recession, even as the rest of the euro zone
EURUSD, +0.4665%
witnesses a modest recovery.

Unemployment is punishing, rising to 11.1% of the workforce in December. The trade deficit is already 2.2% of GDP, and rising all the time — a worrying sign for what was traditionally a major manufacturing and exporting economy.

In reality, the French economy has been living on past glories for a generation. It is now just one crisis away from meltdown.

Two, the U.K. Britain is recovering at one of the fastest rates in the developed world, and unemployment is down sharply. But don’t be fooled.

In fact, the British have cleverly recreated a mini-version of the 2005-2008 boom. Rising debt, and soaring house prices, are reviving the economy, with a massive government debt and low interest rates throwing fuel on the fire. But it is just as unbalanced as it ever was, and its banking sector is just as bloated. The trade deficit is getting close to 4% of GDP — higher than ‘fragile’ Indonesia, and not much less than India.

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